Saturday, June 4, 2011

I've had some mean things said about me regarding my respect for Paul Krugman, and not all from anonymous internet commenters. Some people that ought to be more professional have, in the past, said some not-nice things about me personally over my thoughts on Krugman. You know what, though? It's not my fault Krugman has insights that seem to pan out and well constructed arguments for those insights.

The quality of critiques of Paul Krugman are very depressing to me. People mostly whine about his partisanship or his tendency to lump a lot of mid-century macro together and exaggerate their mistakes. These may be valid critiques, but they're pretty banal as far as I'm concerned.

A lot of people are worried right now about a double-dip as bad news about early 2011 continues to mount.

In 2009, Krugman noted that we'd start to see trouble in early 2011. He's citing Menzie Chinn and Deutsche Bank too, but they're all on the same page in terms of this analysis. The stimulus would have its peak effect on GDP growth at the end of 2009, it would have its peak effect on output in late 2010, and the unwinding of the stimulus would be a drag on GDP in early 2011. This is how it played out. And there was no mumbo jumbo. No fancy epistemology. No political philosophy. No morality tale. A few cracks at politicians, at most. He made a prediction, provided a reasonable explanation, and over a year later we're seeing it essentially play out.

1. Noted in 2009 that GDP growth would peak in late 2009 and we would start to see problems in late 2010/early 2011

2. Noted that despite tremendous increase in base money, interest rates and inflation would not increase, and

3. Has a straightforward explanation for these occurrences, preferably one that was (a.) fully fleshed out before the crisis occurred, and (b.) consistent with a wide range of the data that's out there

Then we can talk. Otherwise I'd prefer we all acknowledge that Paul Krugman is an important economist to listen to and digest. You may not like his style or his politics. That's fine. But don't act like I'm some kind of thoughtless minion for noting that the man is intelligent, articulate, insightful, and most importantly: seems to be right on a variety of occasions where I'm simply not aware of others being so consistently right.

I suggest that people pick their favorite blogs and start working through posts from 2009. See what you think of them after revisiting it with about a year and a half's perspective.

We can add Brad DeLong to the list, but Krugman distinguishes himself by the specificity of a lot of the predictions, whereas Brad does a lot of the work conceptualizing the problems we're facing and being a watchdog of sorts.

He seems like a good, decent, and intelligent man. A lot of his critics have way more skeletons in their closet, and a lot of the attacks do seem unfair. My approach is to study as many different economists as I can to pick out the best information.

I disagree with Krugman on trade for example, and he would probably think the people who disagree with him probably just don't understand the brilliance of the Keynesian models, but when it's a matter of "my lying eyes deceive me" and the fact that I just don't see how it's helped the third world as much as it should I just can't get on board. Most libertarians of course prefer his theoretical work, but I actually like his columns and stuff better. I think trade is one area where economists need to go back and look at the data.

That Krugman is a lightning rod for so much economics angst is undoubtedly linked to his political profile, IMHO. (As a non-American, it took me a little while to come to terms with the sheer vitriol -- and devotion -- that he inspires... But it started making more sense as I've become more familiar with the noxious nature of US politics.)

That being said, I know of no other economist that manages to be at once so pithy and prolific. Apart from the (inconvenient?) fact that his predictions have played out better than most, his gift for conveying arguments -- on many complex topics -- in simple, compelling terms is all but unmatched. You certainly don't have to agree with him to appreciate the fact that he sets the bar, as far as economics communication goes. Even his most ardent critics would be the worse off for not reading him.

Krugman always seems to be playing an angle. He is a good economist, but I do not intend to become a regular reader. I have other, more important, things to do, like pick my nose and scratch my butt. Time is scarce.

I read Krugman's blog and read his book. I was introduced to Krugman through some right-wing economists/posers who now have zero credibility (the kind of people who had to downplay the housing crisis until it was undeniable).

He's a bit too willing to trust his political instincts when investigation is called for. The worst instance was in the case of Jared Loughner. By the time Krugman had formulated his response, there was good evidence that Loughner was a schizophrenic nut, not a right winger. Because of confirmation bias, Krugman was unable to find what he didn't already know.

The New York Times column is written by two people. Robin Wells and Paul Krugman. Krugman writes the first draft, and Wells has a veto on what stays and what does not. Then she adds her own rhetoric. Such has been claimed by a New Yorker journalist who observed them during the column writing process.

Krugman has been an apolitical for most of his life. His sudden shift towards becoming publicly a political happened only after he started his column, after he was 50. But, as the New Yorker reported, Ms. Wells has been so fiercely political, she allegedly left the US, because Reagan was elected.

Let's be clear - there is a distinct possibility that all of his political columns are written by Wells, while Krugman - who has been on the middle of the road on most political issues for most of his life - more or less just accepts what Wells believes in politics when he is asked to do so. ;)

I have to agree with argosyjones, Mattheus. If you now think the Fed can control inflation and keep money supply growing, interest rates down, and inflation low then I'm really not sure what there is left of the Austrian complaint except for a political philosophy point about the legitimacy of the central bank.

I think inflation is low because of macroeconomic circumstances, not the machinations of the Fed. Expansionary monetary policy can lead to inflation under certain conditions. If you think the Fed can keep inflation under control then I've been very confused about your position before now.

..."Let's be clear - there is a distinct possibility that all of his political columns are written by Wells, while Krugman - who has been on the middle of the road on most political issues for most of his life - more or less just accepts what Wells believes in politics when he is asked to do so. ;) ..."

It's clear that many Austrians jumped the gun when warning against inflation in 2008 and 2009 (and many still are). It's not a problem with Austrian theory (not that anybody was saying that it was), rather economists who were not being very careful with their analyses and predictions. They hadn't considered all the caveats which should have been considered, and actually manifested themselves during the recession.

Btw, these economists were warning against inflation precisely because of the "dials" being turned by the Federal Reserve. The problem is that price inflation (which is what these economists were referring to, not just monetary inflation -- they were talking about an increase in the CPI) has more to it than monetary expansion, even if ultimately monetary expansion is the cause of the expected inflation. Specifically, what wasn't considered were the existing obstacles which effectively limited the amount of new money that actually entered circulation.

Will there be high inflation in the future? My answer is still 'yes'. When in the future? I can't really tell you, because I can't predict when the aforementioned "obstacles" will no longer be there. I don't even know enough about our current banking problem to tell you exactly what these "obstacles" are! Nevertheless, I do recognize that unless the monetary base is deflated in the future, that new money will cause a rise in prices.

Jon I have to disagree with you about high inflation. There's absolutely no signs of runaway or high inflation right now when you look at core inflation and right now inflation is around 2.5%. If we were to see it start creeping upwards to around 4%,, the fed would likely start raising rates and reserve requirements before it becomes a problem.

Good post, Daniel, and I should say that Krugman's blog is probably my favorite, in the sense that if he stopped blogging, my day would be ruined. (Of course, I read it to be amazed at how someone so smart could come up with such a compelling argument for what I think is crazy policy advice.)

Some quick reactions though to temper your enthusiasm:

* I think Krugman flip-flopped on the bank bailouts. He initially was grudgingly OK with TARP, then later he seemed to be a "fight the power" kinda guy, and then he was pointing to the Iceland/Ireland examples to show that he was right for saying (in those cases) that bailing out banks was dumb. Later some people called him on it, and he said it was a difference in the size of the bailout relative to GDP, but the whole thing seemed pretty convenient to me.

* The Keynesians were totally wrong on the Obama stimulus. I have an article coming out on Monday on this. Yes yes, I know I know, you will say, "Bob, Krugman said from Day One that it wasn't big enough! He totally predicted all this!" But actually I don't think he did. Again, you can wait for Monday cuz I give all the links, but if you re-read Krugman's analyses in early 2009, he is basically agreeing with Romer's projections (more or less), but he thinks *her own numbers* show that the Obama stimulus isn't closing the output gap.

This is kind of a big deal. What you are basically saying (if I'm right in the above paragraph) is that (a) Krugman thought the stimulus would help, even though it hurt, but (b) he correctly predicted that when the spending ended GDP would fall. Those aren't contradictory positions, by the way. If you thought the stimulus would hurt the economy, there's no reason it would be hitting *at the moment of spending the funds*. Rather, it would be early on, once the policy was announced and everybody adjusted to the tax burden etc. (Or at least, I'm sure a Chicago School guy could model it like that.)

* The only thing that really infuriates me about Krugman is how he is completely unsympathetic to people who disagree with him; he would rather ridicule them than fairly present their views. The classic example is when he repeatedly kept saying Casey Mulligan got his views about New Keynesians in a bar, since Mulligan thought NK's based their models on sticky wages and prices. Well duh, of course that's what they do, as my classes at NYU and even the Wikepdia entry say. So Krugman should have been a lot gentler in his response to Mulligan, saying, "Yes in a 1st year class that's what we teach, but in terms of practicing New Keynesians during a liquidity trap, blah blah blah..."

I don't know what you mean by "nominal values". My point is that an increase in the monetary base is not the same thing as an increase in the quantity of money in circulation (which is what directly effects the determination of prices). Once the new money enters circulation there will be inflation corresponding to the new level of money in circulation. Given how drastically the monetary base was expanded, once this money enters circulation there will be high inflation.

The reason why we haven't seen high inflation is only because the new money hasn't entered circulation. Instead, it forms part of banks' large reserves.

"Nevertheless, I do recognize that unless the monetary base is deflated in the future, that new money will cause a rise in prices. "

And the excess reserves created by QE WILL be drained, just as they were in Japan in 2006.

Despite QE in Japan from 2001–2006 there was high inflation afterwards.

"My point is that an increase in the monetary base is not the same thing as an increase in the quantity of money in circulation (which is what directly effects the determination of prices).

Well done. This is a point other Austrians can't understand. We live in an endogenous money world.

"Once the new money enters circulation there will be inflation corresponding to the new level of money in circulation"

This is typical of Austrian apologists: they live in a fantasy conceptual world where there is ALWAYS full employment/no idle resources.

The main effect of this new spending in an economy with high unemployment, significant unused capacity and idle resources will be to increase production and employment, just as the main effect of increased private spending from idle, already existing money would be the same.

Inflation is a secondary effect, and will be nothing more than a sign that the economy is roaring back into life, just as there were inflationary periods under the 19th century gold standard during booms.

"The only thing that really infuriates me about Krugman is how he is completely unsympathetic to people who disagree with him; he would rather ridicule them than fairly present their views. "

That is pretty much an apt description of hordes of Austrians too.

And what can you say about Austrians who are incapable of understanding basic Keynesian concepts like potential GDP, the output gap etc, and who think Herbert Hoover's miserable spending increases should have cured the Great Depression?

While I understand you pride yourself on your lack of manners, I have nothing to do with the Mises Institute and no interest in defending or proving anything about them. Conflation is a fun game to play on the internet, but not for yours truly.

When I say nominal values I'm referring to wages and prices. And yeah you're right, we would see high inflation all that money entered into circulation over a short period of time, but I don't think that's going to happen simply because we're undergoing a slow recovery and businesses are reluctant to borrow as well as with banks loaning. If the economy did start picking up speed at a rate faster than what the fed thinks it will then the the fastest thing they could do is raise reserve requirements.

I can't comment on Japan, but I don't see any reason to believe that current excess reserves will be drained or that they can even be drained without adverse consequences.

Regarding inflation and idle resources, if these resources are truly idle then any new money creation that leads to the employment of these resources shouldn't lead to significant inflation. A fall in the quantity of idle resources is just a rise in resources that are being bid against.

High inflation suggests that the increase in the quantity of money in circulation was in excess.

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Octahedron,

Right, I'm talking about the long-term. Like I said in the original post, it's really impossible to predict when it'll happen.

I have to agree with argosyjones, Mattheus. If you now think the Fed can control inflation and keep money supply growing, interest rates down, and inflation low then I'm really not sure what there is left of the Austrian complaint except for a political philosophy point about the legitimacy of the central bank.

I should have been more specific. However, it was mostly a rhetorical comment and I didn't expect the responses I got.

The interest rate is a direct creature of the Fed, and there's no point arguing over the direction of it to show how certain economists are wrong, anymore than it makes sense to look at the minimum wage and use that as a barometer for "employment" or "wages." It's a political construct that is totally devoid of any market feedback (2 bubbles in 10 years should be proof), so I found your comment "How are interest rates doing?" to be pedantic and totally hollow. Austrians point out that when/if the Fed ever lets go and allows the market to set the interest rate, it will go sky high. I certainly don't think the Fed will let interest rates climb to 6% or 10%. But they probably would without the Fed. So pointing to the interest rate now with the Fed controlling it is completely vacuous.

As regards inflation, I meant monetary inflation. Not necessarily price inflation. As Jon is always quick to educate me, there is more to price inflation than direct changes in total money supply. That said, the Fed does not have a huge arm to control the CPI and the like. But it does control the amount of money in the economy, so in that sense it indirectly has a strong influence on inflation.

The problem with the Fed isn't just philosophical, Daniel (and you should know this). The problem is precisely that it tries to control inflation, the interest rate, etc. and when it succeeds, we get bubbles and crises. The Fed is able to exercise "stability" in the short run by sacrificing health in the long run. That's the problem.

I always thought that one important argument for abolishing the Fed was its inability to control inflation/deflation because of knowledge problems and that kind of stuff.

The knowledge argument you're referring to is Hayek's. Essentially, it follows that no central authority detached from a profit and loss mechanism (like the Fed) can rationally allocate resources in the best interests of the consumers. The Fed has no way to know if the correct rate is 5% or 4% or 4 and 1/2%. So, it always overshoots or undershoots (and historically mostly undershoots) leading to crises and recessions.

The only thing that really infuriates me about Krugman is how he is completely unsympathetic to people who disagree with him; he would rather ridicule them than fairly present their views.

This, I think, is a fair criticism. At the risk of coming across as die-hard Krugman defender, however, two points for consideration:

1) I recall Scott Sumner writing a post to the effect of, "I always used to wonder why Krugman seemed so frustrated given the influence he wields... But now, having reached a relatively prominent position in the blogosphere myself, I too am frustrated by my total lack of real impact." In other words, Krugman's intolerance should probably be weighed up against the fact that he likely sees himself slogging a relentlessly uphill battle... with no shortage of vitriol coming his way in the process. I'm sure we'd all develop a thick skin under those circumstances. (Well, that, or crumble into a quivering pile of self-doubt, but PK is nothing if not self-assured and confident in his own beliefs.)

2) From memory, Krugman was at least partially gracious to you, personally, in the column where he described your sushi-island allegory for ABCT. (http://nyti.ms/fUYwte) Perhaps some cold comfort in that!

I'm always taken aback by the implication, presented by (some) Austrians, that the rest of the economics profession is somehow unaware that monetary expansion can cause price inflation. I mean, like, what was that Milton Friedman fella going on about again?

That being said, the focus on CPI is borne out precisely because there isn't always a direct, mechanical relationship between money supply/stock and prices. And, yes, there are exogenous shocks that impact the prices of goods, which are exacerbated by the fact that certain prices are stickier than others. (Matt Rognlie had a great post on this topic recently, which I recommend.)

To summarise, it's not that "mainstream" economists failed to understand that quantitative easing would place upward pressure on prices. No, that was the exact point and, rather, they wanted to counteract the slide towards a (debt) deflationary spiral that was becoming manifest as a result of the liquidatory forces of the recession.

[Caveat: Yes, I know that there are other important arguments over the extent to which broad money supply is endogenous/exogenous, how useful the equation of exchange is (MV=PY), etc etc... However, here I'm just interested in the basic principle of a rise in prices being linked to expansionary monetary policy.]